US fund flow and US profitability

According to last Thursday’s flow of funds data, US corporate profits before tax and dividends rose to $1860bn at an annual rate during Q4 2011, up from $1050bn in Q4 2008. In the domestic non-financial sector, corporate profits have risen by around 20% from their lows and after tax and dividends, profits in this sector now amount to $466bn, up from a low of just over $300bn in the crisis. As a percentage of GDP, total corporate profits are now around 14%: one of the highest levels ever recorded. This, some have suggested is a reason to expect a CAPEX led boom in the USA in 2012. However, we must also note that although profit ratios are remarkably high, US profits in aggregate fell 1.5% over Q4 and are basically unchanged from early 2011. On a GDP basis, profits after tax and dividends in the domestic non-financial sector were down fully 10% over Q4 and back to mid 2010’s levels. These figures would not seem worthy of a new CAPEX boom.

More fundamentally, even these profits, and particularly the rate of profit in the economy, have been heavily reliant on support from the government, and this support may or may not be continued after the elections.

From first principles, the profit rate is inversely related to the economy’s savings rate, and in the 1990s and particularly the mid 2000s, US household savings rates collapsed as people spent on average $106 of every $100 they earned. The profit share of GDP naturally increased (particularly since the government budget balance stayed roughly constant at that time). However, when the global financial crisis forced households to start saving, the profit rate collapsed.

Since 2008, US households have generally held their savings rate in a range of 4-5% and their financial surplus has generally been around $500bn per quarter at an annual rate (and Q4 2011 was roughly right in line with this ‘average’ performance, although some households did incur some more consumer credit while others apparently hoarded deposits). This suggests that they are spending around $96 of every $100 that they earn, which is clearly not overly helpful for corporate profits. However, the US government is spending around $140 of every $100 it takes in taxes and this level of dis-saving is obviously hugely supportive of profits. The government is spending money on goods and services made by companies that it has not had to raise in taxes on companies and at the same time it is giving households money to spend that companies have not had to give them. Hence, the budget deficit has been the main driver of the US profit renaissance, not cost cutting, retrenchment and similar.

It is interesting to note that the expansion in the ongoing budget deficit from $400bn per quarter in 2007 to $1.3tn today has resulted in a $400bn increase in corporate profits and a $600bn increase in wage incomes. In short, it can be argued that virtually all the US’s relatively modest income growth since 2007 can be attributed to the wider budget deficit. Given that most people must eventually expect the budget deficit to close, this would not seem to offer a good reason to expect an investment boom.

That said, there are specific micro-led investment booms occurring in the US at present. The US manufacturing sector is competitive and doing well, but it is only 10% of the economy and entrepreneurs and ultra small cap companies are also doing well. Even the property market is stirring. These developments will contribute to some growth in CAPEX this year (although they may be offset by other weaker factors elsewhere in the aggregate data. But they do not imply that an economy-wide investment led boom is forming that will lift total GDP substantially.

James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla